Google’s On2 Technologies Acquisition Is At The Mercy Of Merger Arbitrageurs

December 8, 2009

We live in an era of bumps in merger payments that the buyer thought had been negotiated, and Google (GOOG) is about learn this the hard way in its $106 million acquisition of On2 Technologies (ONT). As the stock market continues to rally shareholders whose companies get acquired are depressed to see that they are stuck with stale valuations from the time their mergers were first negotiated. In the meantime, Facet (FACT), Diedrich’s (DDRX), Hiland and others see their buyout prices bumped up. So we have sympathy for the owners of On2 Technologies who refuse to vote in favor of the acquisition of their stock by Google for $0.60 worth of Google stock.

That’s not $0.60 in cash but $0.60 worth of stock independent of Google’s stock price. The problem is that $0.60 worth of Google stock are a lot fewer shares today than back in August when the merger was announced. Google has since risen from the $450s to the $580s, or 29%. The merger consideration has remained constant $0.60. Had management negotiated a fixed exchange rate of, say 0.0013 shares of GOOG for each ONT, then shareholders would receive $0.77 worth of Google stock for their shares now.

The flipside of a constant merger consideration is that it has become much less dilutive for Google. Instead of issuing roughly 235,000 shares based on Google’s August share price, Google will now have to issue only 182,000 shares (assuming the VWAP for GOOG will be around $580).

Management is in a frenzy to line up enough votes to get the deal approved in the December 18 shareholder meeting. Every day another SEC filing is made extolling the advantages of the deal and threatening the dire consequences if shareholders vote it down. This is a clear sign that they lack votes to close the deal.

Merger arbitrageurs are the joker that will determine the outcome of the shareholder vote on December 18, The arbitrage community holds a significant share of On2. Technologies. We attribute holdings some 15% of the shares to holdings by arbitrageurs, based on our analysis of 13F holdings data collected by Whale Wisdom:

Name Holdings on 06/30/09 Percentage on 6/30 Holdings on 09/30/09 Percentage on 9/30 Change in shares
ARBITRAGE & TRADING MANAGEMENT CO

6,545,681 3.71% 6,545,681
SHOREWATER ADVISORS LLC

5,313,966 3.01% 5,313,966
ARNHOLD & S. BLEICHROEDER ADVISERS, LLC

2,631,744 1.49% 2,631,744
LOEB ARBITRAGE MANAGEMENT, LLC

2,290,893 1.30% 2,290,893
GLAZER CAPITAL, LLC

2,147,252 1.22% 2,147,252
CENTAURUS CAPITAL LP

1,803,675 1.02% 1,803,675
AQR CAPITAL MANAGEMENT LLC

1,604,076 0.91% 1,604,076
GLG PARTNERS, INC.

1,348,228 0.76% 1,348,228
WATER ISLAND CAPITAL LLC

1,026,059 0.58% 1,026,059
BARCLAYS GLOBAL INVESTORS UK HOLDINGS LTD 1,003,273 0.58% 999,683 0.57% -3,590
GAMCO INVESTORS, INC. ET AL

722,969 0.41% 722,969
CREDIT AGRICOLE S A

722,466 0.41% 722,466
CALIFORNIA PUBLIC EMPLOYEES RETIREMENT SYSTEM 367,430 0.21% 486,430 0.28% 119,000
DIMENSIONAL FUND ADVISORS LP 424,063 0.25% 423,263 0.24% -800
HARRIS FINANCIAL CORP 305,000 0.17% 305,000
GEODE CAPITAL MANAGEMENT LLC 185,014 0.11% 272,299 0.15% 87,285
CNH PARTNERS LLC 257,729 0.15% 257,729
LONGFELLOW INVESTMENT MANAGEMENT CO LTD PARTNERSHIP 200,000 0.11% 200,000
UBS AG 845 0.00% 199,995 0.11% 199,150
VERITABLE, L.P. 252,400 0.15% 118,600 0.07% -133,800
RENAISSANCE TECHNOLOGIES LLC 114,000 0.06% 114,000
BANK OF NEW YORK MELLON CORP 112,490 0.07% 112,490 0.06%
NORTHERN TRUST CORP 96,374 0.06% 110,345 0.06% 13,971
MORGAN STANLEY 49,292 0.03% 104,325 0.06% 55,033
KNIGHT CAPITAL GROUP, INC. 62,353 0.04% 62,353
HUNTINGTON NATIONAL BANK 50,000 0.03% 25,000 0.01% -25,000
BLACKROCK INVESTMENT MANAGEMENT, LLC 19,400 0.01% 19,400 0.01%
FISHER ASSET MANAGEMENT, LLC 17,700 0.01% 17,700 0.01%
PRUDENTIAL FINANCIAL INC 10,100 0.01% 10,100 0.01%
WELLS FARGO & CO/MN 2,000 0.00% 3,000 0.00% 1,000
METLIFE SECURITIES, INC 2,000 0.00% 2,000 0.00%
AMERIPRISE FINANCIAL INC 1,900 0.00% 1,400 0.00% -500
VANGUARD GROUP INC 971 0.00% 1,364 0.00% 393

This was per 9/30, a full two months prior to the record date for the meeting. We would not be surprised if their holdings of shares have since doubled. As we pointed out in our book about merger arbitrage, the outcome of many mergers is driven by the arbitrage community whose holdings often reach the 30-50% range during the merger process. A study by Micah S. Officer (“Are Performance-Based Arbitrage Effects Detectable? Evidence from Merger Arbitrage,” Journal of Corporate Finance 15, No. 5 (2007), 793–812) gives examples of the percentages reached historically in some mergers.

Arbitrageurs generally try to take a quick gain and move on. With the current price of On2 Technologies the spread comes to around 20%, depending on your assumptions about commissions and the closing date. So it will be tempting for arbitrageurs to support the deal and take that quick and easy return. However, it is also possible that the arbitrage community has smelled blood and will reject the deal, challenging Google to increase its consideration. Some of the arbitrageurs on the list are of the more aggressive variety and we would not be surprised if they challenged management.

For Google, this is its first purchase of another public company. So they are still learning and probably won’t mind bumping the price, especially not if the transaction is so small that it is a mere rounding error in their financials. They simply have to increase the exchange ratio to the level they were willing to pay back in August. That would boost returns to shareholders significantly and win over the support of the arbitrageurs.

We doubt that the transaction will collapse completely. It makes sense for Google from a strategic point of view. Building their own video compression software is certainly a possibility, but in the typical tradeoff between buy or build they are probably better off acquiring a firm that has a technology that actually works. Not to mention that in acquiring On2 Technologies they can use the technology right away. Time is of the essence if they want to use video as a driver to push their Android operating system into the mobile market. Therefore, we think that Google will eventually increase the exchange ratio to 0.0013 so that investors get as many shares as they would have in August. There remains upside in On2 Technologies beyond $0.60.

Disclosure: Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which engages in merger arbitrage and owns shares of On2 Technologies. He is the author of the book Merger Arbitrage: How to Profit from Event-Driven Arbitrage (Wiley Finance, 2009).


American Community Properties Trust May Attract A Higher Bid

October 6, 2009

American Community Properties TrustSurprise, surprise! American Community Properties Trust (APO) is selling itself. And you won’t even get market value for your shares: while ACPT trades between $8.35 and $8.50 the buyout will happen at $7.75.

The sudden sale at a discount to the market price comes out of the blue for shareholders who still remember the failed attempt by the Wilson family, the 50.68% owners, to take the company private in 2007. The Wilsons had engaged a financial adviser Read the rest of this entry »


The End Is Near For Wilshire Enterprises

August 25, 2009

Wilshire Enterprises (WOC) finally launched its $2 tender offer for 4 million shares, roughly half of the outstanding shares. It is a bad deal for shareholders and we anticipate that worse is to come because public shareholders will be minority holders in a firm whose management has a record of poor decisions, such as the refusal to sell at $8.50 to Mercury Real Estate Partners a few years ago. Read the rest of this entry »


Cash Shells: SPACs, MathStar, PetroSearch and Cadus

July 28, 2009

It has been a while since we first reported on SPAC liquidation arbitrage in January. The battles over MathStar (MATH) and PetroSearch (PTSG) has prompted us to follow up, as did our annoyance with the slow progress at Cadus (KDUS).

SPACs represented a great liquidation arbitrage late last and early this year when they traded well below their cash value at double-digit annualized yields. Other companies trade occasionally below cash, usually when Read the rest of this entry »


Will Shareholders Vote Down Entrust’s Private Equity Buyout?

July 5, 2009

In another illustration of the pointlessness of “Go Shop” periods the board of Entrust (ENTU) ignored three buyout offers received in the 30-day go shop period that were higher than that of the group that includes the CEO. Moreover, the Entrust management buyout shows all that is wrong with buyouts by private equity funds where management remains with the firm and has an incentive to lowball the buyout price. Shareholders expected an increase of the $1.85 merger consideration, and shares traded as high as $2.10 during the go-shop period. We believe that due to the high level of dissent from shareholders and even a board member it will be difficult for management to achieve the required approval by 2/3 of the shareholders. Read the rest of this entry »


Pershing Square Misleads About General Growth’s Equity Value

June 8, 2009

Pershing Square LogoPershing Square Bill Ackman’s presentation about General Growth Properties (GGWPQ) at the Ira Sohn Investment Research conference has us wondering what he is up to. The tone of the presentation clearly targets an audience that is not familiar with bankruptcy investing. At the same time, his financial projections for GGP are overly optimistic and do not square (no pun intended) with current results. We believe that some of his analysis is very misleading. Read the rest of this entry »


Is A Sale Of Wilshire Enterprises Imminent?

March 30, 2009

The shareholder meeting of Wilshire Enterprises (WOC) has been adjourned for the second time. This is actually the third delay of the shareholder meeting, which was originally scheduled for February 26 in Wilshire’s preliminary proxy materials. The meeting was then set for March 24th and at the last moment adjourned to March 30th. Today, the meeting was adjourned again to April 20th. Read the rest of this entry »


Wilshire Enterprises’ Future Decided This Tuesday

March 20, 2009

Wilshire CEO Sherry Wilzig Izak with Mina Otsuka, her brother "Sir Ivan" and friends (left to right)

Wilshire CEO Sherry Wilzig Izak with Mina Otsuka, her brother "Sir Ivan" and friends (left to right)

The end of the first round is approaching in this years most underreported proxy fight, the battle over Wilshire Enterprises (WOC) between Phil Goldstein’s Bulldog Investors and Wilshire’s CEO Sherry Wilzig Izak. Two directors will be elected at Tuesday’s meeting, and shareholders will also vote on proposals to end the staggered board, seek a liquidity event and abolish the poisons pill. We have written extensively about the battle previously (here, here). Read the rest of this entry »


Dirty War Over Wilshire Enterprises

February 25, 2009

Wilshire CEO and party girl Sherry Wilzig Izak with her brother "Sir Ivan"

Wilshire CEO and party girl Sherry Wilzig Izak with her brother "Sir Ivan"

The battle over Wilshire Enterprises between Phil Goldstein’s Bulldog Investors and Wilshire’s (WOC) CEO Sherry Wilzig Izak is gradually growing into a full scale war, if not a jihad. Among a string of litigation, the shareholder meeting was postponed from this week to March 24th, giving management crucial time to beef up their defenses that ultimately will be futile. We have previously chronicled the battle between Wilshire and Bulldog, which ended in a temporary defeat of Bulldog when management declared that “initial bids are in” for a prompt sale of the company. Almost a year after the initial bids, a buyer emerged for $3.88/share, down from $8.50 a few years ago when management rejected a bid by Mercury Real Estate as “undervalued”. Last year’s buyer didn’t have enough funds to acquire Wilshire, and the stock now trades just over $1.

With the date of the shareholder meeting approaching, the fight over Wilshire is heating up. Wilshire’s management is fighting hard to keep Bulldog out: Read the rest of this entry »


The State Of The Hedge Fund World

February 22, 2009

Rosy forecasts were in short supply at the first annual Wharton Hedge Fund Conference. The shock of last year’s worst-ever performance still reverberates through the industry. Career plans of students at Wharton are the best indication we have seen to date of how bad things have become for hedgies: one Wharton professor reports that last year, two thirds of his students wanted to get a job in a hedge fund. This year, only one student admitted to hoping for a hedge fund career. Read the rest of this entry »


In Defense Of Securities Class Actions

September 24, 2008

Former shareholders of Chaparral Resources should receive the proceeds of the settlement with Lukoil (LUKOY) in the next few days. The settlement checks were mailed on Monday, we were told by a lawyer involved in the case. We have written about Lukoil’s shenanigans in the acquisition of Chaparral Resources before. As majority shareholder, Lukoil manipulated Chaparral to depress its stock price and acquire it at a low price. Shareholders filed a class action and are now, two years after the fact, finally receiving compensation. Read the rest of this entry »


KeyBanc’s Poor Fairness Opinion In Max & Ermas Restaurants’ Buyout

June 24, 2008

Max & Erma'sLast week’s announcement that Max & Ermas Restaurants (MAXE) had a rough second quarter, with the weak economy and the March blizzard hurting top and bottom lines, made us wonder whether we should expect yet another busted buyout. After all, bad quarterly results have triggered quite a few merger cancellations, for the most part unjustifiedly. However, when we saw KeyBanc’s (KEY) deplorable fairness opinion we were convinced that the buyer is getting such a good deal that there is a lot of room for deteriorating performance before the deal will be called off. Read the rest of this entry »